Tuesday, February 21, 2012

The Reality of Pareto

I was in a training session at work for a new quality program that was being implemented. They flew this guy over from the states who was the global training lead for this new program. He asked the class if anyone knew who Pareto was. I said he was an economist. He asked me to provide details. I provided a quick summary of Pareto's work (after all, we did spend an entire class one school day in Economic Analysis of the Law discussing Pareto efficiency).

Trainer: Um... well, that's not the same guy as who I'm thinking. Basically, Pareto was this guy who had discovered a very important statistical trend that is today known as the Pareto Principle. Blah, blah, blah...

Me: Ugh... /wanted to desperately explain to the guy how they're exactly the same person.

OK, quick note on teaching. When you are teaching or training people, there will always be someone who plays "stump the prof". I do this now and then. I see lots of people do it. When we do this, we're not trying to make the "prof" look bad. We're genuinely curious about something and want it figured out through dialogue. Or we're bored with the discussion and want to turn it into something more enlightening. Or we're annoyed that something incorrect is being taught. Or maybe sometimes we're just mean, but I don't think there are many who really care to do that. They have other motives, being students. If you're teaching and you encounter a "stump the prof" situation, don't feel embarrassed. Don't back off. Don't get combative. Engage with your students.

OK, back on topic. The Pareto principle basically describes how the majority of stuff is associated with the minority of people, causes, etc. Normally, the numbers are 80-20: 80% of the wealth in a nation can be owned by 20% of the population; 80% of the problems are caused by 20% of the causes. Etcetera. We were being trained on how to identify the 20%. Basic stuff that you learn in any business school.

When you look at movements like Occupy Wall Street, they've altered the framework a bit. Now it's the 99% vs the 1%. It's not like the 1% hold 99% of the wealth, but they hold a significant amount (about 40%). Unfortunately, due to various factors, the 1% is probably a systemic, natural result. Even if the 1% are broken down through revolution, a new 1% will just arise. This seems to be a natural power law.

Case in point? Look at China. There was a lot of strife because of, among other things, the big divide between the rich and poor. So Mao rose up and started the revolution, with the peasants landing on top. Well, over time, we have arrived at the exact same situation again. The wealth gap between the 1% and 99% is way bigger than what exists in the USA and is much more visible. This is probably a simple side effect of the fact that China's population is much bigger, so percentage calculations result in amplified gross numbers. It is very odd to hear people in the west constantly talking about how rich China is now, how China is the benefactor of the US due to being owed so much US debt, etc. The fact is that these statements may be true at a macro level, but at a micro level inside the country, it's not such a simple picture.

There is a HUGE wealth gap between the rich and poor in China. You have millionaires who have no problem buying tons of fancy cars, expensive brand name bags, bubble-level real estate, etc. Then you have the girl in the bakery who's making only $150 per month, while the most basic apartment also costs $150 per month. Lucky for most employees, the employer is usually willing to provide living quarters at a cheap price. Of course, it usually comes out of the $150 per month, unless it's in the factory where it might be free. Well, in the factory, you make more money, but it's a dog fight to get in, and the conditions are horrible by western standards. Even further, there are still many who live in villages without basic plumbing. Since the wealth gap is many times blamed on corruption, the general populace is very upset to the point where any rich girl flaunting pictures of her wealth on the web causes a national media circus (and tough questions for parents that might work for the government). The complaints are very similar to the ones that Occupy Wall Street make about Wall Streeters and the bailouts in the US.

So we have this strange dichotomy where the west views China as very rich, with growing power, while inside China, the poor are plentiful. This dichotomy is not made any easier from the fact that it was the peasants who took over and then sent any remaining rich/powerful/freethinking people to re-education camps. Basically, the whole country became poor, and all the rich/powerful/freethinking people who had the means left for locales like Taiwan, HK, etc, before things got really bad. And if you're a believer of what Malcolm Gladwell wrote in Outliers, it's hard for a people group to shake attitudes and lifestyles that have been in place for hundreds of years, meaning that it's difficult for many of these people to stop thinking like peasants. And yet, a new 1% still arose.

Think about it. We have a real-world experiment that turned an entire large country upside down in the quest to eliminate wealth gaps, but failed in that quest. The corresponding interesting question is whether any other ideas would really solve the issue. It's easy to say that China failed to solve wealth gaps because Communism doesn't work as an economic system (which is an entirely different subject altogether and will not be discussed here). The thing is, capitalism hasn't really solved the problem yet either, if it will ever. Very few countries in the world actually have solved it. The exceptions are a small number of European nations, but the difficulty scale of their problems is much smaller due to the smaller population sizes. Never mind that they have their own economic issues right now.

If anything, I think the symptoms of the Pareto principle will be more entrenched over time. There are a number of factors that I believe will feed into this, but I think the primary ones to consider are globalization and technology. I think these two factors do more to destroy jobs than anything else. But don't label me as a left-wing free market hater. I also think they do more to create jobs than anything else. The problem lies in how to cross the chaotic chasm in between point A (jobs destroyed) and point B (jobs created).

Globalization is the easy one to analyze. If you open up international trade so that anything can be manufactured and sold anywhere, simple product manufacturing (eg. clothing, accessories, trinkets, etc) will always be manufactured wherever the labour is the cheapest because not a lot of capital investment is required (relatively speaking). So the jobs for manufacturing simple things will disappear in the wealthier nations and become abundant in the poorer nations. We saw this happen with simple manufacturing moving from western nations to Asian nations like Korea and China. Now it is happening again, moving from China to Vietnam, Thailand, Indonesia, etc. Imagine that. China is losing jobs because of globalization.

Once again, the important question? In the wealthier nations, who are losing those jobs? Well, those jobs are usually filled with unskilled labour, so therefore cheap labour. It's the uneducated, unskilled, and poorly paid people who are losing the jobs. And because they're uneducated, unskilled, and poorly paid, it's obviously difficult for them to find new jobs, once the jobs they were capable of doing get moved overseas. The effect is exacerbated when even office jobs like tech support, legal support work, etc, get shipped overseas due to outsourcing. So the rich will stay rich, and the poor will stay poor.

It is interesting to note that for high-tech manufacturing, many people in the industry agree that cost of labour does not factor primarily into the decision. Read interesting articles on that here. And here. And here. And finally here. I remember hearing a talk from the CEO of a new solar panel company based in Vancouver, BC. He was asked by an audience member why the company chose to build a manufacturing plant in the BC interior instead of in China. He said it was because he was proud to be making a Canadian company and the cost really isn't that different. The main cost is in the capital investment, plant equipment, etc. That cost is similar whether in Canada or in China. The labour as a percentage of cost is tiny and therefore doesn't factor into the decision.

Technology is a bit more out of left field. Technology is supposed to free our minds and give us new abilities, or at least that's what the advocates say. And to a certain extent, that's true. It is the case that people in the middle east were actually naming their newborn babies Facebook to celebrate how social media and the web had played a part in coordinating the Arab Spring Uprisings. It is the case that there was no way you could make money as an SEO expert 20 years ago (the concept didn't even exist because the web didn't really exist). But it is also the case that the primary purpose of technology in a company is to increase productivity. And the most natural way for it to increase productivity (perhaps the only way) is to automate tasks.

This hit home for me only recently, as I reflected upon my career. I started out as a software developer for a telecom company in Canada. We were a special swat team that went throughout the organization to automate solutions for difficult or stupid business problems. All of us were recent grads from university. So you had a bunch of bright-eyed kids automating systems and processes being handled by people who had worked at a job for 20 years. All of a sudden, no job. Said people were either given a package for early retirement or reassigned to new work. Except within a few years, maybe that new work would get automated too.

Technology has a huge ability to create new opportunities. But in the process, it destroys the old ways. It is a natural economic phenomenon labeled by Joseph Schumpeter as creative destruction (well, according to Wikipedia, maybe he adapted the idea from the Marxists). The problem exists when the people who were depending on the old ways for work cannot easily retrain themselves for the new economic paradigm. And when you have a ton of people who are unable to easily reinvent themselves, you have a lot of unemployment. I remember discussing things in a PMP prep class with some fellow classmates. One lady had commented on how her company implemented SAP and then was able to lay off the entire accounting department. This technology stuff is scarily powerful. P&G is laying off thousands from its marketing departments after discovering how much cheaper it is to just market stuff on the web with some web marketing specialists (greater economies of scale for one thing).

The important question this time: why can't these people reinvent themselves easily? First off, reinventing oneself is not an overnight thing. People go to school for years to attain the skills they have for a job. Or they're an apprentice for some time for some trade. Either way, you're looking at a significant time investment and income drop just to get your foot in the door. And employers don't want rookies in various fields where they have need. No, employers want qualified people that can hit the ground running. It costs too much to take inexperienced people and train them up. Especially when those inexperienced people are demanding high wages because they still have a mortgage and kids to feed. It's only after reading about the stories of the long-term unemployed that I realize there's a huge disconnect here between what technology hopes to do and how newly unnecessary employees are supposed to become employable again. There are jobs out there right now. High-quality software engineers simply cannot be found in a very big tech boom. Again, SEO experts didn't even exist 20 years ago.

What's the answer? I don't know. There are much smarter people than I working on these issues. That being said, I think we can conclude that the most important skills people need these days and well into the future are not in specific technical skills or domain knowledge. That comes and goes and may get totally automated tomorrow. Traders? Probably. Doctors? Possibly. Software developers? Heck, I saw prototypes of stuff that automated simple application development back in 2005. The list goes on. Yeah, some small niche of jobs in whatever category has always remained after getting totally automated. But that doesn't comfort the vast majority of people in those job categories who had to reinvent themselves.

Rather, the most important skills are probably the ability to learn and adapt to new environments quickly, think on one's feet, be creative and innovative, and take calculated risks to do new things. These are skills that people already need to learn today. But they'll probably be even more important in the future for that time when your job is suddenly outsourced to another country or automated out from under your feet. Technology's capability to change the world seems to be only accelerating, so it'll be harder and harder to adapt in a timely manner. Good luck, huh?

The last thing I'll say is that I think it's unfortunate when people think they can solve the negative effects of globalization and technology through policy. If the two things are unstoppable forces, no policy is going to prevent them from doing their damage. The policies that need to be created need to focus on containing the damage and prepping for the new reality so that the pain endured during the transition is minimal and everyone is ready to party rock when the transition is complete. That would probably involve a lot of education and training programs, but hopefully not for skills that will become obsolete quickly.

Who is PakG1?

I'm a Vancouver Canuck fan now living across the pond in China. My interests include disruption, global trends, Go (also known as Baduk or Weiqi), information asymmetry, games, innovation, languages, reading, skiing, and volunteering.